College-planning math can bring on a serious brain cramp. Financial Advisor Ric Edelman urges focus on this number instead—tax-advantaged 529s.
The facts: tuition is rising, student loan politics can be volatile (see the Tackling Tuition sidebar below), high debt levels potentially suffocate graduates as they navigate early careers, and some feel paralyzed by a perceived trade-off between investing for retirement or college.
For many financial advisors, including author and speaker Ric Edelman, chairman and CEO of Edelman Financial Services, LLC, these factors reinforce the appeal of tax-advantaged 529 college savings plans as part of a broad approach to financial preparedness.
We pulled Ric from the podium for a quick Q&A:
Ticker Tape Editors: So first up, your thoughts on that all-too-familiar question: retirement saving, college saving, or both?
Ric Edelman: It’s a shocking notion to some, but parents’ primary obligation must be their own retirement planning. If you hold a 30-year mortgage, you get to live in the house while you pay it off. If you borrow for college, you pay off that debt while you work. Guess what? There’s no pay-as-you-go during retirement. Unlike houses, cars, and college, you must pay for retirement before you get there.
TT: Does that mean many families don’t have their priorities straight?
RE: Parents have to understand that college expenses have increased exponentially compared to when they attended. And the return on investment is different, meaning not all career choices compensate for the cost of training and education as they once did. Many require advanced degrees. Skip college? No one’s suggesting that. But these challenges explain why a 529 plan can be an important piece of broader financial planning: there’s a very reasonable point of entry. [Editor’s note: The TD Ameritrade 529 College Savings Plan does not have a minimum investment; the plans grow tax-deferred; and there’s more flexibility than most people realize, for instance, renaming beneficiaries to other family members without incurring income tax or penalties should a child’s needs or plans change.]
TT: Are there disadvantages to 529 plans that investors should weigh against the positive features?
RE: Some commentary will center on a lack of flexibility—earnings on withdrawals not used for qualifying college expenses are subject to taxes and a 10% IRS penalty, and you can make investment changes for the existing dollars in your account only once per calendar year. And, there are limited investment choices. But the opportunity for tax-free growth offered by 529s may outweigh the benefits that an alternative investment approach might offer. I also think investors need to make a distinction between college savings plans and tuition pre-payment plans (TPPs). I’m a strong proponent of the former. The latter have a variety of significant limitations that might make them less attractive. For example, TPPs do not cover room and board, which is half the cost of college. They are designed for use only with state colleges where you live—a problem if you move or if your child wants to go elsewhere—and some states have discovered that they can’t honor the promises they’ve made to investors. As a result, those programs have either shut down or reneged on their promises. For the large part, College Savings Plans have avoided these problems.
TT: What do you say to investors who might feel it’s too late to get started or that their efforts won’t make a dent?
RE: Obviously, one of the benefits of a 529 is the chance to let money grow tax-deferred over time, so the sooner a plan is created, the better. But for parents who don’t start until their kids are teenagers, a 529 can still be effective. Keep in mind that you’ll have at least four and likely five or six years of undergrad costs to plan for. So, for instance, if a plan is started when a kid is 15 and they need resources through age 23, that’s eight years for a plan to grow. You might try for loans, scholarships, or work-study to pay for tuition and expenses for the first years and then tap the 529 in the final years of school. Plus, if a family has more than one child headed to college, there is flexibility in changing beneficiaries to other family members without adverse income tax or penalties. The first child’s tuition brings sticker shock, often, and then the reality that there’s a need for planning kicks in--so that you can get all the kids through college. 529s are really about family planning and, unfortunately, 69% of parents did not know what a 529 plan is, according to a 2013 survey by Edward Jones.
TT: Are there ways to stretch the benefits of 529 investing?
RE: Communication is a great way to limit college-cost surprises. For instance, talk to kids about their career and higher-ed aspirations to help determine the best fit so you can hold down costs. Often, the first year of college is merely 13th grade, so families should consider starting a student at a community college for one or two years to get the basic courses out of the way and then transferring to a state or private institution to sharply reduce the cost of a degree. Scholarship and financial-aid research can be time-consuming, but is often well worth the effort. For some families, eliminating room-and-board costs by living at home or off campus is an effective approach, too.
When asked, 1960s incoming UCLA freshman said they attended college with hopes of making the world a better place. By contrast, today’s students often say they go to college to get a better job and earn more money. So it really is all about return on investment (ROI) these days. Few employers ask a job candidate where they spent their first two years of college—they just care that you have the degree. And subsequent employers care mostly that you have the experience and skills to do the job. So it’s important that students don’t spend more for their degree than is necessary from an ROI perspective.
TT: Thank you, Ric.